Asia should be on guard for asset bubbles: HSBC

Frederic Neumann, co-head of Asian economic research at HSBC, strongly believes Asia is at risk of seeing asset bubbles surface. Capital controls are a likely tool for defence but it should not be the only one.

Asia is at risk of blowing asset bubbles. The US Federal Reserve's latest round of quantitative easing is only adding fuel to the fire. The process is all too familiar: loosening of monetary policy in the West, along with a weaker dollar, is sending investors across the world searching for yield. Asia, still standing tall after the harsh winds of the global financial crisis have begun to settle, is receiving most of these funds.

Fixed income markets rallied first, with dollar instruments leading the way and quickly followed by locally denominated debt. Low interest rates, too, quickly began to spark a rally in real estate markets. Both of these continue their run as the flood of money is washing up on Asia's shores. Equity, however, has lagged so far, but looks equally poised to soar as the run-up elsewhere has sent investors scurrying for yet more risky assets to buy.

The road to bubble formation is quite uniform across countries. Even smaller markets, so-called frontier economies, are now being swept up by the tide of liquidity. Regulators everywhere are watching the process unfold with growing concern. After all, across the region memories of the Asian Financial Crisis remain fresh. A repeat of that episode is certainly not desired, although many of the outside investors now knocking on Asia's door appear unaware of the region's bumpy history.

What officials can do to temper asset bubble and inflation risks is less clear. Raising interest rates alone may attract more funds than it would deter. Allowing for a faster appreciation of exchange rates, too, might only serve to draw in more cash. That leaves regulatory responses, whether capital controls or other restrictions on lending locally. This latter path appears increasingly likely, although it shouldn't be relied upon as the only weapon in policy-makers' arsenal. More effectively, a mix of the above policies might just do the trick. But there's little time to waste. Officials in Asia are quickly finding out that it sometimes does pay to fight the Fed.